Sentiment Survey May Show Glimmers of Inflation

The Federal Reserve wants inflation to rise, and on Friday, officials got one of the first signs that may happen.

The twice monthly University of Michigan consumer sentiment survey reported that as of early November, consumers’ expectation of inflation in the one year range moved up to 3% from 2.7% in October. While that number reflects expectations and not actual inflation like that which is measured by the government, it deals with a key psychological element to the inflation cycle. Economists widely believe that inflation expectations are important because what the public thinks about future prices drives price pressures today.

To be sure, surveys of consumers’ expectations of inflation have had a difficult history in academic studies of the issue. How the question is asked can often lead to different responses. That said, the Michigan survey suggests something may be afoot.

The Fed wants higher levels of inflation. Officials are, however, careful in how they phrase that desire. The most recent policy statement of the Federal Open Market Committee described inflation, once stripped of volatile food and energy factors, as “somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.”

The Fed is understood to want core price pressures, as measured by the core personal consumption price expenditures price index, to range somewhere around 1.5% to 2%. In September that reading was 1.2% on an annualized basis. Central bankers and many private sector economist worry that weak growth and high levels of unemployment mean there’s a good chance this measure could go even lower, perhaps even devolving into an economically destructive bout of price deflation.

That’s the key reason why the Fed opted last week to restart an aggressive and controversial program of buying longer-term bonds, which they hope will ease credit conditions and drive growth toward higher levels. Contained within this view is the hope inflation will ease back toward the targeted range without exceeding it.

Some central bankers, including New York Fed President William Dudley and Chicago Fed President Charles Evans, have even publicly explored allowing above-target inflation for a time, to compensate for price pressures undershooting their ideal range. But that would be a big and unlikely step for the Fed to take, especially since it doesn’t even have an official target now.

Fed Chairman Ben Bernanke last Saturday was careful to say that while he is “very sympathetic” to those worried about the Fed’s new stimulus efforts, “we are not in the business of trying to create inflation.” He added, “I have rejected any notion that we are going to try to raise inflation to a super normal level.”

But even so, higher inflation is what the Fed is trying to engineer. Jefferies & Co. economists reacted to the Michigan report by saying “deflationary expectations appear to be abating and the Fed’s [asset-buying] program is already working in increasing inflation expectations.”

Bernanke’s cautious words, however, show what a dangerous path the central bank is on. If expectations were to come unglued–there’s already considerable anxiety about the Fed’s activities–it would be a bad deal all around. The Fed would potentially have to tighten monetary policy regardless of the level of growth, and that bid to maintain inflation-fighting credibility could cause even more economic pain.

About Real Time Economics

Real Time Economics offers exclusive news, analysis and commentary on the U.S. and global economy, central bank policy and economics. Send news items, comments and questions to the editors and reporters below or email realtimeeconomics@wsj.com.